What is an L Bond?
An L Bond refers to an unrated life insurance bond that finances the purchase and premium payments of life insurance contracts bought in the secondary market. The bond offers a higher yield than other publicly traded offerings to compensate for the risk that the insurance policy benefits may not be paid. People buy life insurance policies from insurance providers with the goal of protecting their beneficiaries after they (policyholders) die. The protection may be in the form of monetary compensation to bridge the gap left by the policyholder.
The policyholder may decide to sell the policy in the secondary market when they are unable to continue paying the insurance premiums, no longer need the insurance protection, or they are in need of urgent cash flow. The person who purchases the policy now becomes the beneficiary, and if the original policyholder dies, the buyer will receive compensation from the insurer.
After the purchase, the buyer is now responsible for making the premium payments to the insurance carrier. The buyer purchases the life insurance policy for more than the surrender value but less than the benefits expected. The buyer profits from the transaction by aligning the expected returns/benefits with the life expectancy of the original policyholder.
How an L Bond Works
Minnesota-based company GWG Holdings, the parent company of GWG Life, buys life settlements contracts from policyholders at prices that exceed the surrender value. The company finances these purchases through the sale of high-yield bonds and preferred stocks to buyers that are looking to invest in instruments that have a higher yield than those in the stock and bond markets. GWG Holdings sells unrated bonds, which come with a higher risk than other instruments in the stock market. According to the firm’s fact sheet, L Bonds are considered speculative and are subject to a higher degree of risk such as the risk of losing the investments.
Maturities of L Bonds
L Bonds come with maturities ranging from two to seven years. Previously, GWG offered L Bonds with 6-month and 1-year maturities, but the company scrapped them in September 2016. Long-term offerings include 2 years, 3 years and 5 years. The interest rates are 5.50% for 2-year bonds, 6.25% for 3-year bonds, and 8.50% for 5-year bonds. The bonds are illiquid, and investors must wait until maturity to access their investments.
GWG Holdings also issues preferred stocks that pay a dividend of 7% and come with a conversion option. The issuer can recall them before the maturity date and their proceeds correlate to the life insurance policy purchased from the original policyholders. In a situation where the insurance provider goes bankrupt or does not give accurate predictions to its policyholders, the company may be unable to make timely interest payments, and this will affect the prices of its offerings. Also, unlike the L Bonds and preferred stocks, the GWG’s common stocks are liquid, and investors may redeem them before maturity for cash.
Attractiveness of L Bonds
Although L Bonds come with a high degree of risk, they are attractive to investors due to their high yields and short-term maturities. Also, unlike other alternative investments that are highly correlated to certain segments of the market, L Bonds are not correlated to the equity or fixed income markets. Alternative investments like REITs are correlated to the real estate market, and any positive or negative effects in the latter will directly affect the prices of REITs.
Characteristics of L Bonds
- Investors can purchase L Bonds from GWG Holdings or a Depository Trust Company participant.
- L Bonds are sold in denominations of $1,000. The minimum amount of investments that an investor can purchase is $25,000.
- L Bonds are illiquid investments, and the holders cannot sell them on the secondary market. They need to wait until the bonds mature to redeem the principal amount. It is highly unlikely that these bonds can be purchased in the secondary market.
- The interest rate for a bond remains fixed for the entire term of the bond, even if the market interest rates change. If an investor wants the new rate applied to their portfolio, they must wait until maturity and review the terms of the bond.
- L Bonds are callable, and the issuer possesses the right to recall the bond at any time before the maturity date without a penalty. It may occur when market interest rates fall below the interest rate offered by the issuer.
- Holders of L Bonds cannot redeem the bond before the maturity date, death or disability of the policyholder. However, if GWG agrees to redeem the bond for any other reason apart from the above reasons, the bondholder will be charged a penalty of 6% on the withdrawn amount.
- Upon maturity, the L Bond is automatically renewed unless the bondholder decides to redeem the bond.
- An L Bond does not correlate to equity or fixed income markets, and its value is not affected by the volatility of the financial markets.
How GWG Holdings Operates
GWG Holdings is a leading issuer of the high-yield bonds. The company purchases life insurance settlement contracts from seniors in order to make wealth. For example, the firm may purchase a 5-year $5-million life insurance policy that pays $100,000 a year for $1 million. When the policy matures, or the seller dies, the insurance provider pays GWG Holdings $5 million in life insurance settlements. The funds raised from the policy are used to purchase additional life insurance assets.
The first GWG L Bond issue was in August 2012 for a $250-million offering. The issue was fully subscribed by December 2014. The firm issued the second L Bond offering of $1 billion in January 2015 with maturities of 2 to 7 years. In total, the company sold over $400 million worth of L Bonds through its independent broker-dealer channel of over 5,000 advisors. The company also entered into an arrangement where the L Bonds are available through Depository Trust Company. In 2016, GWG announced that it held over 500 policies with total insurance assets valued at $1.15 billion.
An L Bond is an investment vehicle that offers high yields to compensate investors for the risk that the insurance premiums or benefits may not be paid. It is used to finance the purchase and premium payments of insurance contracts purchased in the secondary market.
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